Why moral hazard fails in health care

I’m going to take the time to review a topic that is one my pet peeves, one you hear bandied about all the time in discussions of more consumer directed health care.  It’s a topic I came back to repeatedly on my old blog – the moral hazard.

Basically, the moral hazard is the idea that people insulated from risk behave differently than people exposed to risk.  For instance, once you have good car insurance, you may drive less carefully, because you are more protected.  In health care, some apply to moral hazard to posit that once you have good insurance, you are more likely to use health care – even if you don’t need it.  In my favorite example of this (because I find it amusing, not because I agree), if we all had employer paid grocery insurance, we would demand filet mignon instead of hamburger.  This would evidently lead to skyrocketing food costs, the end of sales, and mass starvation.

It’s important to understand that people who apply the moral hazard to health care believe that people are using too much, and that’s why our costs are too high.  They believe that if we somehow changed health care, and exposed people to the true costs, they would become better consumers, and the whole system would cost less.  Knowing that more than 45 million people have no health insurance, and tens of millions more are underinsured, I tend to think the biggest problem – and the one that most people feel – is because they’re not getting enough good care.

But let’s take the moral hazard argument seriously.  I believe it fails, both in a theoretical sense, and in an empirical one.

As a theory, the moral hazard in health care was first described only about 40 years ago in a seminal paper by Mark Pauly.  And it’s still just a theory.  Like many theories, it has its good points and bad; it’s not an undisputed law.  For instance, recent work by John Nyman explains that the moral hazard may actually do good in health care by encouraging people who otherwise would not seek care to do so.  We want sick people to get care.

And think about it.  That supermarket example isn’t even remotely comparable.  If I made colonoscopies free tomorrow, no one would start picking them up by the dozen.  If I declared no one would ever have to pay for chemotherapy again, you wouldn’t ask for extra.  If surgeons refused to accept payment for appendectomies anymore, would anyone go and get one just for the hell of it?  We have a hard enough time getting people to do the things we want them to do to be healthy without having to expose them to more hardship to get them.

I love filet mignon.  No one loves going to the doctor.

Moreover, this argument assumes that we have no skin in the game.  Really?  The average employer provided family health care policy in the United States is over $13,000.  And they still have co-pays and co-insurance.  I have phenomenal health insurance through my job and it still costs me $100 to take my kid to the ER.  I feel that.  My prescriptions have co-pays, sometimes up to $25 dollars.  That’s money.  Many, many people have it much worse.  People with insurance, too many of them, go bankrupt every year from medical expenses.  They aren’t shielded from the costs.

But you know I like evidence, and it’s available here as well.  The most comprehensive health policy study ever performed was the RAND health insurance experiment:

The HIE was a large-scale, randomized experiment conducted between 1971 and 1982. For the study, RAND recruited 2,750 families encompassing more than 7,700 individuals, all of whom were under the age of 65. They were chosen from six sites across the United States to provide a regional and urban/rural balance. Participants were randomly assigned to one of five types of health insurance plans created specifically for the experiment. There were four basic types of fee-for-service plans: One type offered free care; the other three types involved varying levels of cost sharing — 25 percent, 50 percent, or 95 percent coinsurance (the percentage of medical charges that the consumer must pay). The fifth type of health insurance plan was a nonprofit, HMO-style group cooperative. Those assigned to the HMO received their care free of charge. For poorer families in plans that involved cost sharing, the amount of cost sharing was income-adjusted to one of three levels: 5, 10, or 15 percent of income. Out-of-pocket spending was capped at these percentages of income or at $1,000 annually (roughly $3,000 annually if adjusted from 1977 to 2005 levels), whichever was lower. The 95 percent coinsurance plan in the study closely resembled the high-deductible catastrophic plans being discussed today.

I could write volumes on the meaning of the results, and the good and bad things about this study.  It has been interpreted and misinterpreted too many times to count.  But here’s the gist of that they found: People in the high deductible plans – those most exposed to health care costs – did spend significantly less and consumed less health care.  And, yes, much of that care was unnecessary, as healthy people did not suffer negative consequences  from forgoing care.  BUT, and this is important, poorer participants with hypertension avoided necessary care, and saw their mortality rates rise significantly.

Removing the moral hazard did no harm in the majority of patients (which is touted often as the result of the study) because they were healthy.  And, of course, getting less care when you’re healthy leads to few short term negative results.  But for those who were unhealthy, who comprised a minority of patients in the study, removing the moral hazard led to significant and dangerous consequences.

And that’s the most important lesson from all of this.  Removing the moral hazard as it relates to health insurance is fine for most people.  Yes, if we make it more expensive to seek care, if we demand more “skin in the game”, if we remove the moral hazard, people will seek less care.  That’s fine for healthy people; it’s terrible for those who are ill.  But for whom is the health care system intended?

Aaron E. Carroll is an associate professor of Pediatrics at Indiana University School of Medicine who blogs at The Incidental Economist.

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  • Finn

    Thank you for both clearly explaining the gaping flaw in the moral hazard argument and citing evidence to back it up. I’ve tried to point out that those of us who are sick are in no position to start comparison shopping, and those of us who live in rural areas don’t have enough options to shop around even if we want to. Far too many people seem to believe that enormous numbers of people on Medicaid, Medicare, or private health insurance are demanding–and getting–completely unnecessary MRIs, CT scans, and expensive brand-name drugs simply because they don’t have to bear the entire cost. When I ask for evidence to back up these claims, what I get is either no reply or a few anecdotes.

  • http://medicalpastiche.blogspot.com Peter

    It is undeniably obvious that there is something wrong in healthcare when patients choose not to see their physician for routine medical care for chronic conditions and when that choice leads to increased morbidity and mortality in the future. Unfortunately, the author does not address key components of why patients are forced to make such decisions, and instead makes claims that a fundamental and widely-recognized aspect of insurance failure should be even more greatly relied on to make sure sick patients require the care they need.

    The author fails to state that patients do not have enough money to pay for a physician office visit, reasons for which include being unemployed, being underemployed, being in a job that does not have a high income, choosing to pay for a wide variety of non-healthcare items and not having enough money left over for healthcare. Further exacerbating the problem patients have with affording office visits is that these visits are too expensive, reasons for which include high bottom-line costs for offices from hiring billing personnel to deal with all the regulations from the government and the effects passed down to insurance companies, high-energy costs, high real estate costs.

    None of the above cost problems which prevent patients from seeking care I mentioned above involve moral hazard. So, let’s take a look at what moral hazard contributes:

    1) Price opacity, where a patient does not seek the cheapest treatment or diagnostic tool because “someone else is paying for it, so who cares how much it costs” or where a patient is willing to have a surgery of low marginal benefit because “I might as well use the insurance benefits if I have it” or where a patient does not shop around for the lowest-priced or most efficiently-run physician office.

    2) Price opacity which when used across the board by patients in a health insurance plan, invariably increase insurance premiums across the board, making it more difficult for individuals within the plan to afford it and it prices out those without insurance who actually want to buy insurance.

    3) Overuse of emergency room services, where patients will go to the ER for hangnails, cold medicine, work physicals, disability applications, etc.

    4) Failure of patients to be motivated to value their own health because of the notion that someone else will pay for their healthcare in the future.

    If the author’s recommendations are to be taken seriously and incorporated into our healthcare system, prices will skyrocket even further and resources will be even more overused, more people will lose insurance because they will not be able to afford the skyrocketing premiums which will lead to an inability to pay for catastrophic costs in the future such as emergency surgery, there will be higher costs for physician office visits with increasing utilization of insurance billing, there will be even more price opacity where patients will be more insulated from the most cost-effective options for diagnosis and treatment and instead choosing the more expensive options, and price insensitivity on the order physicians’ part because of the third-party payor.

    The author does not address why healthcare is so expensive in the first place, but if he attempted to do so, he would have realized that healthcare is so expensive precisely because of moral hazard, the very principle he argued to promote. If moral hazard were minimized and the root causes of expensive healthcare resources, then healthcare would be much more affordable in this country and the people who truly need healthcare, i.e. the sick, would be able to receive it.

  • jenga

    As I read this, I thought one thing, I’m pretty sure this author has never seen a worker’s compensation patient and guess my suprise when I read that Dr. Carroll a pediatrician.

  • pj

    “No one loves going to the doctor.”

    I respectfully disagree- this may be true for children but if I had a dime for every pt. who came into the ofc. essentially because they wanted to despite not needing to, I could pay off my $50k of med school loans…

  • Paul Dorio, MD

    Here here, Peter. I couldn’t have said better. I would only add that it may be palatable to some if the system allowed two components:

    1- price transparency and consumer involvement in their care from a cost standpoint,
    2- decrease the amount each patient is to pay depending on the severity of the ailment. I suggest this part to hopefully combat the tendency of people to forego care because of cost, a valid concern.

  • http://ushealthpolicygateway.wordpress.com/ Chris Conover

    This analysis glosses over the fact that the RAND study found that cost-sharing had adverse outcomes only for low-income patients with hypertension and vision problems. For everyone else, i.e., regardless of whether they were sick or well, cost-sharing had NO adverse health consequences. But failure to use cost-sharing surely had enormous economic consequences. In the free care plan (no cost-sharing), fully 30% of cost of care was wasted (waste being defined as the difference between the value of the care to the patient vs. the cost to society to provide it, i.e., if because of insurance I obtain a $100 lab test that I’d be only willing to pay $25 for absent insurance,$75 is waste).

    Food is surely more consequential to life and death than most medical care, yet we do not preemptively offer universal food insurance to avert the possibility that some may not be able to afford their own food needs. Nor do we create government-run grocery stores. We simply give those without the means to pay vouchers (!) called Food Stamps to enable them to buy what they need in the private market. This is a far more efficient (and arguably fair) way to deal with the problem that there always will be some among us who lack the means to fully provide for themselves.

    • Marc Gorayeb, MD

      Well said. The bias that the original post exposes is that egalitarian ideologues refuse to consider means-testing of services. It’s the same reason they won’t tolerate any notion of means-testing social security payments or medicare-funded services. They will not consider the option of having a different form of medical insurance for people with chronic illness, in which financial subsidies would be means-tested. It ruins their egalitarian vision, which they appear to hold with religious fervor.

      • Dr. Dredd

        But if you have a different form of insurance for those with chronic medical illness, aren’t you segregating the sicker (e.g. more expensive) people into their own risk pool? I thought the whole point of insurance was to spread the risk among a large number of people so that the truly healthy would balance out the truly sick.

        • http://medicalpastiche.blogspot.com Peter

          Dr. Dredd,

          What you are describing insurance to be is actually socialized wealth-redistributive healthcare.

          The real purpose of insurance is actually to analyze the risk of individuals and classify those individuals into separate groups and to adjust individual premiums so that enough funds are raised to cover future expenses. High-risk individuals will pay proportionally higher monthly premiums compared with low-risk individuals because the future outlays are much greater with those who are higher-risk.

          Consider auto insurance: those who drive recklessly, get multiple speeding tickets, or cause multiple auto accidents will pay significantly more in their monthly premiums than those who never get into accidents and drive cautiously. If auto-insurance operated like how Obama “reformed” healthcare, then high-risk drivers pay the same amount as the low-risk because of the prohibition on risk-adjustment, everyone is forced to buy insurance which unnecessarily covers monthly interior cleanings and exterior car washes, and the old beater you wrecked in 1980 because you were driving drunk would have to be covered and repaired under any new insurance policy because it was a “pre-existing condition”.

  • Anon

    “Basically, the moral hazard is the idea that people insulated from risk behave differently than people exposed to risk”…

    Kinda like the theory: Anonymity+Computer+Audience=@%!Hole!

    Not so much on this post, just a theory.

  • gzuckier

    This just underlines the point that we don’t actually have health insurance; we used to, like BlueCross; you paid out of pocket until you ran up some bills you couldn’t afford, then your insurance kicked in. What we have now is almost the opposite; “all you can eat” for a fixed monthly cost, unless you get too expensive, then they toss you out of the restaurant. So attempts are made to modify the process with copays and deductibles and so on.

    But healthcare is different, as pointed out; by and large people don’t want to consume healthcare. Yes, lonely and troubled people seek help with office visits for minor or invisible complaints; yes malingerers seek an excuse to get workman’s comp. But it’s not the procedures themselves they want. (Except for cosmetic surgery and prescription narcotics). Nobody blows their lottery windfall on dialysis treatments. ‘I don’t really need it, but what the heck, you only live once’.

    And people just aren’t in the habit of shopping around for medical care; I’m skeptical that the majority of them are equipped to do so competently. Heck, it’s obvious that the majority of the public don’t have the knowledge to shop for cars or electronics competently, I doubt they can evaluate the competing claims of various pharmaceuticals, or case-mix adjust the outcomes of competing hospitals.

    And there are so many things nobody really knows the costs of; does the PCP who refers to a specialist really know what the specialist’s fee schedule is, and how that compares to a different specialist, and how the difference in fees correlate with a difference in success rates (case-mix adjusted, of course)? The insurers are breaking their necks right now trying to get cost info out to members in the hope that subsequent cost-sharing will drive their behavior, but a lot of organizations have confidentiality agreements in place that prohibit this.

    Interesting times.